Know Your Risks

  • Equity Crowdfunding
  • P2P Investing
  • Real-estate Crowdfunding
  • Invoice Discounting
  • Passion Assets
  • Blockchain Investment

 

Risks of Equity Crowdfunding

The equity crowdfunding market is still in its infancy and continues to evolve at a fast pace, and that is why this list may continue to evolve in the coming years. You should never assume you have all the information in startup investing and always question assumptions or common beliefs. It is wise to understand the risks associated with an investment before getting involved.

 

1. Illiquidity

If you have a liquid investment, this implies that it is relatively easy to buy and sell at any time. An illiquid asset is much harder to buy and sell whenever you want. Equity crowdfunding and private markets are considered highly illiquid investments. This is because once you invest your money, it will be locked up for many years. You cannot simply choose to sell if you change your mind or need your money back, and you have almost no control over when you will get your money out.

Equity crowdfunding will become more liquid as secondary markets are established. Secondary markets are the exchanges where you will be able to buy and sell your shares of private companies to other investors, prior to that company having an exit or a liquidity event.

2. High Risk of Failure and Loss

Most businesses that seek financing through crowdfunding are start-ups or early-stage businesses. Most of the start-ups and early-stage businesses fail. If you invest in a business that does not succeed, you will likely lose all the money you invested. 

For startup investment failures, investors in equity crowdfunding should be aware that we aren’t just talking about companies that go bankrupt and close-up shop. A failed investment should be defined as an investment that returns less than the invested capital.

3. Dilution

Dilution is when additional capital is raised during future funding rounds, resulting in your initial ownership becoming a smaller piece of a (hopefully) bigger pie. Although investors in equity crowdfunding today may not consider this, dilution is a huge potential risk that can seriously deplete investor returns. Thus, it is crucial to consider whether the company you are investing in is capital-efficient, if they are nearing profitability, and other factors that may influence how often and how much additional capital they will need to raise before a potential exit.

4. Limited Information and Lack of Control

You will receive some information, such as an offering document, annual financial statements, annual updates about how the money is being spent and notices about key events, like change in control of the business, but not as much information as you would receive from a public company. The great founders and teams will still provide periodic updates to their investors regardless of the investment amount. But understand that their sharing of proprietary and sensitive topics to hundreds (or more) of investors puts them at greater risk of that information leaking out to competitors.

5. Potential for Fraud

Despite checks made by crowdfunding portals, individuals with ill-intentions may not be completely weeded out from offering shares via crowdfunding. Our regular surveillance keeps a check on such fraud campaigns but sometimes they can escape our sharp eyes. So, before investing, make sure you know everything about that business by having done a thorough background research.

 

Risks of Peer-to-Peer Investing

Risk vs. reward is a principal consideration for every investment decision, not only with P2P risks. However, with peer-to-peer lending (P2P) platforms advertising rates ranging from 3% to 19% the reward can be easily visualised. The challenge, however, relates to assessing the level of risk acceptable to the reward. The nature of lending money to individuals and/or businesses creates unique risks in comparison to traditional asset classes that investors should be aware of.

 

1. Performance Risk

Although some P2P providers have put in place features to recover losses such as providing funds and asset security, there is a fundamental risk that a large number of borrowers default on their loans. A further performance risk exists when an investor's cash sits idle in their account waiting to be matched to borrowers.

 

2. Credit Risk

Borrower default may result from a poor initial credit decision or economic factors. Investors are advised to diversify across a large number of borrowers to ensure that the effects of one borrower defaulting are minimal on the overall investment. A large number of borrowers defaulting on their loan commitments remains a risk even after diversification.

 

3. Interest Rates

If interest rates were to rise, the interest rate paid by a borrower might not appear attractive in comparison to other forms of investments.  The question is clear: can P2P investing still deliver value in an environment of higher interest rates. Well, the good news is that if interest rates were to rise, borrower rates would also rise. In theory, both the lender and borrower rate would rise.

 

4. Unemployment Rates

In the consumer lending space, if unemployment rates were to rise, the risk of borrower default would also rise. A rising default rate caused by unemployment would decrease investor returns and possibly lead to a loss of capital.

 

5. Property Prices

Whether borrowing for property development, as bridging finance or for buy to let purposes, property generally secures the loan. If a loan moves into default the P2P provider has the ability to sell the property held as security. Two things are important here. Firstly, how easy will it be for the property to be sold and secondly, what value will the property or asset be sold at.

If property prices were to drop, the capital realized from the sale of the property price may be lower than expected. Typically, P2P platforms will not lend at 100% of the value of the property (LTV).

 

6. Liquidity Risk

Investors are contractually obliged to lend funds to borrowers over the term of the loan. The inherent nature of lending is therefore illiquid unless the loan can be sold to a new investor. Depending on the P2P platform it may be possible to sell loan commitments on a secondary market.

 

Risks of Real-Estate Crowdfunding

There are some risks associated with real estate crowdfunding that you have to understand and be aware of so that you can make the best decision for your investments and future. 

 

1. Non-guaranteed Returns

The returns in real-estate crowdfunding investments are not guaranteed or assured. So, there is always a potential that your actual returns won’t be as high a projected since the market fluctuates with time and trends.

 

2. Accredited Investors Only

You must typically be an accredited investor to invest in real estate through crowdfunding. Accredited investors have certain income and net worth requirements that generally exclude small investors. Since real estate investments are complex, you must be a sophisticated investor with high net worth. This will help you understand the risks of the investments, as well as be able to absorb potential losses.

 

3. Due DIligence Limitations 

It can be challenging to complete necessary due diligence if you do not live in the area where you are investing. Real estate investors need to specialize in a given region or city to really manage to identify better deals. You will certainly not be able to perform good quality due diligence on an office building located in City A if you reside in City B and have limited knowledge of the City A market.

 

4. Investments Are Illiquid

Real estate investments tend to be long-term in nature, and are not traded on national exchanges. Once you commit money to an investment, you will usually be required to remain invested until it matures. The platforms themselves typically don’t offer a secondary market to sell your investments, either. So, these kinds of investments are typically illiquid and cannot be converted to cash easily.

 

Risks of Invoice Discounting

 

 

1. Limited Availability 

This method of financing is often extended only to businesses with an established, reliable credit control and collection process. This is because the risk involved is very high, as the invoice discounters have no control over the debtor book. The discounters need to make sure they are making a good investment.

 

2. Only Commercial Invoices 

Invoice discounting lenders only offer advances on business-to-business transactions. You cannot borrow against business-to-consumer sales.

 

3. Cost

Invoice discounting is surely less expensive than invoice factoring, but it can still cost more than an overdraft or a loan.

 

4. Dependency

Some businesses can end up getting overly dependent on invoice discounting for liquidity. This can make it difficult to leave an agreement without impacting cash flow and sales levels.

 

5. Dispute Risk

There is also a risk that the Buyer may claim that the goods provided by the Supplier did not satisfy the requirements mentioned in the order. This is a broad term covering a number of different risks and possible claims against third parties. The consequences of this may be a deferred payment, partial payment, or no payment at all. 

There also exists a risk that the Buyer will make the payment to the Supplier or some other party instead of the fund’s provider. Or, the risk that the Debtor(Buyer) will not pay due to financial inability or insolvency

 

Risks of Passion Investment

Risks associated with Passion Investment are different from those associated with other forms of investment. 

 

1. Emotions involved

Under Passion Investment, there is a high level of adoration and emotion involved which sometimes takes over one’s rational decision-making abilities. One must ensure a thorough research and background checks before investing in passion assets and try best to avoid emotions taking control of the actual decision. 

 

2. Storage

With a lot of Passion Assets like Wine, Art and classic Cars, storage is a big risk in itself as any malpractice in storage could lead to to the asset losing most of its value. Such assets need a high degree of care and maintenance and any lapses could lead to a quick drop in the value of such asset.

 

3. Provenance

With some Passion Assets, provenance is an essential attribute which certifies the authenticity and value of the said asset. Passion assets are valuable and unique and that is why there is a high probability of them being faked. So, with passion assets like wine and art, it is best to check for a provenance from a reputed and recognized source certifying the authenticity of the asset.

 

4. Unforeseen Costs

Passion Assets usually require at least some degree of regular maintenance and definitely need to be insured and valued. These are the unforeseen costs associated with such assets as the investor might need to spend on maintenance, insurance or valuation of the asset at any time during his ownership of the asset. 

 

 

Risks of Blockchain Investment

 

1. Lack of Standardization

The wide variety of frameworks means that there is a lack of standardization. This is potentially one of the biggest risks that the current blockchain projects suffer from. These standards apply across the complete blockchain ecosystem including Initial Coin Offerings(ICO), cryptocurrencies, frameworks, and so on. ICOs are suffering the most from the lack of standardization. The investors have no proper protection against the investment, which makes ICOs a big gamble.

 

2. Malicious Users

Malicious users are part of any system or solution and blockchain is no different. They can impact the blockchain network by controlling a particular aspect of it. The risks are real, and it is the duty of the developers to ensure that malicious actors in no condition can take control of the network resources or the consensus method. 

 

3. Volatile Market

The blockchain investment market is constantly rippling back and forth. With such an unpredictable market, there’s no telling if you will get a return on your investment. To avoid a massive loss, keep a vigilant eye on the market. Make small investments; they’ll be more beneficial long-term.

 

4. Cybertheft

Blockchain investment is technology-based, which leaves this investment open to cyberattacks. Hacking is a serious risk, since there is no way to retrieve your lost or stolen blockchain investment. 

 

5. No Regulations

Currently, the blockchain investment market is operating without any major regulations. The government doesn’t have a clear stance on cryptocurrency and blockchain as the market is just too new. It is not taxed, which can make it enticing as an investment opportunity. However, a lack of taxation could lead to problems should bitcoin pose as competition for government currency.

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